What is an Adjustable Rate Mortgage?

Adjustable rate mortgage refers to a loan with a variable interest rate, which cannot be changed. This is remarkably different from a fixed rate mortgage, which could move to different directions depending on the movements of indexes associated with that loan. Mortgage loan borrowers often consider various options anytime they are looking for a loan. This is because mortgage loans are structured in different ways and there are varieties of things they consider such as the terms of such loan. Some of the factors that affect the loans can be negotiated like the closing costs, its interest rates, prepayment penalty, length of payment and several others. When borrowers consider different types of mortgaging loans and conditions attached to them, they always opt for the adjustable mortgage rate, because of the various benefits. The loan is also known as the ARM. The interest charged for this type of loan often starts from a very low end and could be adjusted according to various indexes.

However, as appealing as this loan may be, it is important that you understand the long-term risks associated with it before opting for it. It could be the best thing for you when you are experiencing certain financial conditions, while at the same time, it could also lead to foreclosures. The most critical factor to consider about this loan is whether there is an attached fixed interest rate period of it, as well as the type of index the loan is based on, and the frequency of adjusting such loans. It is also necessary to determine whether there are payment caps on the interest rates and so on.

The first factor you have to consider is the fixed interest rate period of the loan. The most common adjustable rate is known as the hybrid ARM. The specific interest rate for this loan is guaranteed and it would remain fixed for a specific time. Usually, the initial rate for this loan is lower than what you can get elsewhere. The fixed period could change even from a month to years, but that is always determined by what the mortgage lender is willing to concede to you. However, a shorter period would always mean a reduced interest rate.

Many borrowers would prefer to refinance their mortgages; they prefer the ARM, because it offers them the opportunity to pay less interest when compared to a standard loan. Within the fixed period, the borrower would be in a position to ascertain the directions, which interest rate was heading to and decide whether it is ripe to refinance or not. Some people like to refinance towards the end of the period fixed.

Another critical factor that you have to consider is the interest rate index. It is necessary you find out the index used in adjusting the interest rate. It could be worked out based on the bank pay deposits or the present rate of the treasury bonds. Anytime there is an increase in interest rates, the indexes would go up as well. In the same way, the index would come down when the interest rate climbs down.

Margin is another critical factor you have to consider. Margin represents the percentage, which would be added to the current index to work out the interest rate. The margin usually runs from two percent to four percent. Usually margin is included in order to enhance the profit the lender makes, because the indexes are usually very low. Other factors could affect the margin; the prominent among them is your credit. If you have a better credit, you would enjoy a lower margin, but where you have a bad credit, you would have a higher margin. The margin further brings down the interest rate when compared to traditional loans.

Another thing you need to ask yourself is how often the interest rate actually adjusts. Anytime the rate adjusts, you have to find out the next time it would adjust forward. This is important for two reasons. It would help you determine the most appropriate time to refinance. Secondly, it helps you in planning your budget.

Furthermore, you have to find out whether you have an interest rate or you have a payment capped. When there is an interest rate cap, it implies that the rate would increase by a certain amount at a certain time. Various caps are available which would help you prevent an over increase in interest.

We have dwelt a lot on the hybrid ARM, there are other types of ARM, but these are less common. These ones could cause a lot of havoc to your credit, health, and life quality if you misapply them. One of such ARM includes the interest only adjustable mortgage rate. In this type, you do not pay down on the principal; rather, you pay the interest monthly. This is not good because it does not help you to own your home faster and does not help to build your equity. It could be risky because the condition could arise where you would be required to pay the principal.

There are others like the negative amortization mortgage, payment option mortgages, and so on. You to determine the right option before you make a choice. Many people would continue to opt for the ARMs, because of the various advantages. This type of mortgage offers lower closing costs. This is because its loan is cheaper than those mortgages that have a fixed rate of interest.

Moreover, it offers lower fixed interest. If you have an ARM with a fixed interest period, the rate you enjoy is usually lower. This loan offers what is regarded as a generous fixed interest period. Borrowers could save money to pay for the mortgage upfront at lower closing cost. You can qualify for a bigger loan with ease. This is possible, because the initial payment is usually low and does not have a permanent fixed rate. This makes much easier to qualify for a bigger loan. There are shortcomings associated with it as well.

Adjustable rates mortgage are increasing in popularity for obvious reasons. Many people would look for mortgages they could borrow at lower costs and cheaper interest rates; and that opportunity is provided by adjustable rate mortgages.